California HMO Regulations. California HMOs, such as HN California
and our behavioral health plan, MHN, are subject to California state regulation, principally by the Department of Managed Health Care (DMHC) under the Knox-Keene Act. Among the areas regulated by the Knox-Keene Act are:

initial and continuing financial viability of the HMO and its risk-bearing providers,

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provision of services that are culturally and linguistically accessible, and



composition of policy-making bodies to assure that plan members have access to representation.

On September 28, 2000, Assembly Bill 1455 (AB 1455) was signed into law. AB 1455 amended and added several
sections to the Knox-Keene Act. As required by AB 1455, the DMHC adopted final regulations (the AB 1455 Regulations) addressing both claims reimbursement and provider dispute resolution procedures. The AB 1455 Regulations include new and
substantial requirements concerning provider claims handling, such as limitations on the health plans ability to limit the time of submission of claims by providers, standards for payment of providers who are not contracted with the plan,
recovery of overpayment notifications to providers regarding the payment or denial of their claims, disclosure requirements as to fee schedules and payment policies, and limitations on payment policy changes. The AB 1455 Regulations also include
detailed rules concerning provider appeal rights and the plans responsibilities in providing a fast and fair dispute resolution mechanism, including restrictions on the plans timely submission requirements, time period for resolution of
an appeal and for the written explanation of the plans determinations, and an annual regulatory reporting requirement by plans. The AB 1455 Regulations also apply to the health plans provider groups to which the plans have delegated
claims payment and provider appeal functions, and the plans are required to have in place certain oversight mechanisms to assure compliance by their delegated provider groups. In January 2006, the DMHC released a written draft for an 18-month pilot
program to provide independent arbitration of plan/provider disputes to be effective in October 2006. No assurance can be given as to whether this proposal will be implemented in 2006 in this or any other form.

Any material modifications to the organization or operations of HN California
and MHN are subject to prior review and approval by the DMHC. This approval process can be lengthy and there is no certainty of approval. Other significant changes require filing with the DMHC, which may then comment and require changes. In
addition, under the Knox-Keene Act, HN California and MHN must file periodic reports with, and are subject to periodic review and investigation by, the DMHC. Non-compliance with the Knox-Keene Act, including the provisions added and amended by AB
1455, may result in an enforcement action, fines and penalties, and, in the most severe cases, limitations on or revocation of the Knox-Keene license.

Health Insurance Act of 2003. In October 2003, the Governor of California signed the Health Insurance Act of 2003 (the California Health Insurance Act), commonly referred to as pay or play, which would have
required all California employers employing more than 200 employees to pay a fee or show proof of health insurance or other acceptable health coverage for both employees and their dependents beginning January 1, 2006. The California Health Insurance
Act was repealed by referendum in November 2004. The vote to repeal the Act was close and supporters have threatened to circulate an initiative measure to reenact it. No assurances can be given as to whether or not such a measure will be considered
in 2005 or thereafter.

California HMO Regulations.
California HMOs, such as HN California and our behavioral health plan, MHN, are subject to California state regulation, principally by the Department of Managed Health Care (DMHC) under the Knox-Keene Act. Among the areas regulated
by the Knox-Keene Act are:

composition of policy-making bodies to assure that plan members have access to representation,



procedures for resolving grievances,



the interrelationship between HMOs and their health care providers,



adequacy and accessibility of the network of health care providers,



timely and accurate payment of provider claims,



provision of services that are culturally and linguistically accessible, and



initial and continuing financial viability of the HMO and its risk-bearing providers.

On September 28, 2000, Assembly Bill 1455 (AB 1455) was signed into law. AB 1455 amended and added several
sections to the Knox-Keene Act. For example, AB 1455 increased the interest rate that health care service plans must pay on uncontested claims not paid promptly within the required time period and granted the DMHC additional authority to impose
monetary penalties and other sanctions on health plans engaging in certain unfair payment practices (as defined in AB 1455). As required by AB 1455, the DMHC adopted final regulations addressing both claims reimbursement and provider
dispute resolution procedures. The DMHC advised health care service plans to implement them for all services provided on and after January 1, 2004.

Any material modifications to the organization or operations of HN California and MHN are subject to prior review and approval by the DMHC. This approval
process can be lengthy and there is no certainty of approval. Other significant changes require filing with the DMHC, which may then comment and require changes. In addition, under the Knox-Keene Act, HN California and MHN must file periodic reports
with, and are subject to periodic review and investigation by, the DMHC. Non-compliance with the Knox-Keene Act, including the provisions added and amended by AB 1455, may result in an enforcement action, fines and penalties, and, in the most severe
cases, limitations on or revocation of the Knox-Keene license.